Tuesday, October 16, 2007

Indexing

I’m sure you know by now that I am a huge proponent for low expense ratio index funds. Investment gurus Ben Graham, Warren Buffet, and John C. Bogle realized a long time ago that the best way to ensure a fair market return is to own all the common stocks through a total market index fund.

"If the data do not prove that indexing wins, well, the data are wrong." - John C. Bogle

See the charts found on John C. Bogle’s Vanguard Morningstar Invest Forum website to understand why these assertions are correct.

Reversion to the mean (RTM) as discussed by Bogle is the “pervasive law of gravity that prevails in the financial markets—and never stops.” The real market return (after expenses) of owning individual stocks or mutual funds will eventually sputter because of this law. Those stocks and mutual funds that greatly outperform the index are fighting an un-winnable battle; eventually they to will fall victim to the forces of RTM.

My current individual holdings Chipotle Mexican Grill (CMG), Conoco Phillips (COP), and Best Buy (BBY); collectively continue to outpace the S&P 500 and total market index funds. I guess time will tell whether or not these dollars would have been better off in the indexes.

However, I still feel there are certain times to buy and hold individual companies as long as you can handle the ups and downs. I do know; however, some ways to be below average:

- Daytrading. Jumping in and out of all holdings on a daily or weekly basis will hurt you in the long run. Why? Capital gains taxes and trading commissions eat away potential returns

- Buying Penny Stocks. There is a reason why companies trade for less than $1. Do yourself a long term favor and don’t buy them. The risk is not worth the potential return!

- Bandwagon Trading. If you find yourself buying yesterday’s big gainer, odds are you’ve already missed the return

Avoiding these tempting pitfalls will put you on a much more positive trajectory relative to your peers. Trust me; I have tried them all with minimal success!

20 comments:

Nat Beebe said...

Brian, like your blog. COP should enjoy the recent run up in Oil and Natural Gas prices. WTI is up over 30% Y-o-Y, which should help all energy players. I don't play consumers, so don't have any real insight on the other two, besides being a nice hedge against a retreat in oil. I'm trying to set up a blog myself www.alphaenergyblog.blogspot.com still in its infancy, more of a weekly update on the energy markets. Nothing too much yet, but check it out in a few weeks. Best of Luck- Nat

Brian Reese said...

Thanks for reading, Nat!

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